Clients often ask me if it’s time to take profits or sell based on the recent performance of a particular investment. It seems that we’re conflicted about record-high share prices – on one hand we’re pleased to see existing investments gain in value but apprehensive that higher prices are some kind of indication that prices are due to fall.
After asking about the reason for the concern, I like to remind investors that the price of a share in a company is not an object kept aloft through strenuous effort. – It’s simply the price of a small fraction of a company and an entitlement to the company’s future earnings and dividends.
The media and journalists periodically stoke investors’ record-high anxiety by suggesting the laws of physics apply to financial markets—that what goes up must come down. “Stocks Head Back to Earth,” read a headline in the Wall Street Journal in 2012. “Weird Science: Wall Street Repeals Law of Gravity,” Barron’s put it in 2017. And on it goes.
Those who find such observations alarming may shy away from purchasing shares at record highs. But there’s no academic basis for having this feeling. Thousands of business managers go to work every day seeking projects that appear to offer profitable returns on capital while providing goods and services that people want or need. While some new ideas and the firms behind them may end in failure, history offers abundant evidence that investors around the world can be rewarded for the capital they provide.
“Investors should not treat record high prices with enthusiasm or concern. They should treat them as what they are – a price.”
Whether at a new high or a new low, today’s share prices reflects investors’ collective judgment of what tomorrow’s earnings and dividends are likely to be—and those of all the tomorrows to come. Each day the share market is open, shares are priced to deliver a positive expected return for the buyer. Otherwise, no trade would take place. It’s difficult to imagine a scenario where investors freely invest in shares with the expectation of losing money.
When we invest in shares, we expect a positive return, so reaching record highs with some frequency is exactly the outcome we would expect. Using month-end data over the 94-year period ending in 2020, the S&P 500 Index produced a new high in ending wealth in more than 30% of those monthly observations. Put another way, almost 1 out of every 3 months recorded a new all time high.
You might say that this is all good and well for existing investors, but what does it mean for NEW investment? Very little, I’m afraid. Purchasing shares at all-time records has, on average, generated similar returns over subsequent one-, three-, and five-year periods to those of a strategy that purchases shares following a sharp decline, as this table shows.
Average annualised return for S&P 500 Index after market highs and declines
| 1 year later | 3 years later | 5 years later | |
| After new high | 13.9% | 10.5% | 9.9% |
| After 20% decline | 11.6% | 9.9% | 9.6% |
We’re conditioned to think that after the rise must come the fall, tempting us to fiddle with our portfolios. But the data suggest such signals only exist in our imagination and that our efforts to improve results will just as likely penalize future returns.
We can all take comfort knowing that share prices are not fighting the forces of gravity when they move higher and have confidence that record highs only tell us the system of publicly trading assets everyday is working just as we would expect—nothing more.
Thanks to Dimensional for the data and select words in this article.
